MANAGING CREDIT IN INDIA- PART I- Indian Credit System and Current Disruption

MANAGING CREDIT IN INDIA- PART I

(In Times of Disruption Caused by Covid-19 and Economic Lockdown)

Indian Credit System and Current Disruption

Outstanding Credit Tops $4 Trillion

Three groups of borrowers - governments, businesses and households- are final users of credit. Some credit flows take place between the players of the financial system as well.

Combined outstanding borrowings or credit of the governments, businesses and households is of the order of Rs. 300 lakh crores. In dollar terms, outstanding credit stock amounts to $4 trillion @ Rs. 75 to a dollar.

The central government and the state governments together have built up debt stock of about Rs. 140 lakh crores. The central government owes roughly Rs. 100 lakh crore and the states collectively another Rs. 40 lakh crores.

Businesses of all types- agricultural, industry or services, micro, small, medium or large, public sector or private sector- put together, have borrowed from banks, non-banks and other providers of credit in different form- loans, advances, bonds etc. Their outstanding credit is of about Rs. 100 lakh crores.

Households are primarily savers. The households borrow as well for financing houses, vehicles and other consumer durables. They, especially the poorer people, also borrow for current consumption. Estimated stock of credit availed by the households is about Rs. 50 lakh crores.

In advanced economies, there is lot of credit provided to fund wealth creation. Such credit to wealthy individuals and corporates flows from the banks, including central banks. In India, credit for wealth investment- real estate, equity investment, bonds investment etc. is relatively minor.

Indian financial system has also not provided any credit to the rest of the world. India is still a capital deficit country. It has borrowed from the rest of the world, but has not provided credit to it.

India’s GDP is about Rs. 200 lakh crores. The outstanding credit stock of Rs. 300 lakh crores owed by governments, businesses and households at the close of financial year 2019-20 amounts to 150% of GDP. Despite not much of credit funded wealth, it is quite a large stock of debt.

Banks Are Principal Credit Providers

There are five broad classes of lenders or creditors.

The banks, the non-bank finance companies (NBFCs), including housing finance companies (HFCs), the retirement saving funds, including insurance companies, like Employees Provident Fund (EPFO), New Pension Schemes (NPS), LIC etc., the central bank i.e. RBI and the rest of the world lenders- have provided this credit of Rs. 300 lakh crores. Some credit has been provided by the ultimate savers, the households, directly.

The banks are the biggest providers of overall credit. The banks are also the largest providers of credit to businesses. They also provide substantial credit to governments and households.

Outstanding bank credit to the final users- businesses, governments and households- is about Rs. 130 lakh crores.

Including credit funded indirectly, through non-banks, banks outstanding credit is close to Rs. 140 lakh crores.

Credit by the RBI

The Central Bank, the RBI, at the apex, sets the regulatory policies, operates the monetary policy and manages liquidity in the system.

RBI also create and provide credit. RBI is banker to the government and is bankers’ bank as well. Law envisages and permits the RBI to provide credit to businesses as well. However, presently, the RBI lends only to the government.

Outstanding credit of RBI, almost entirely to the central government, is about Rs. 10 lakh crores.

Inclusive of RBI’s credit, the banking systems credit to ultimate borrowers- the governments, businesses and households- amount to Rs. 150 lakh crore or about half of the total credit of Rs. 300 lakh crores.

Rest of the Credit Providers

Non- Bank Financing Companies (NBFCs), including Housing Financing Companies (HFCs), raise their funds from banks, other financial entities handling savings- mutual funds, insurance companies etc.- and from savers directly in deposits and investment in bonds.

The NBFCs and HFCs have about Rs. 50 lakh crores of credit outstanding to the final borrowers- businesses, households and governments. Their credit to the government is relatively quite small.

Remaining savings collecting institutions- Life Insurance Corporation, Mutual Funds, Employees Provident Fund, New Pension Scheme prominently- provide credit primarily to the governments. Households do make provide some of their savings directly to the government, largely through the system of small savings in the country.

Their contribution to the overall outstanding credit is around Rs. 80 lakh crores. These players deploy most of their credit in government securities. Their exposure to businesses and households in India is relatively quiet insignificant.

The remaining credit- about Rs. 30 lakh crore- comes from the rest of the world. This includes investment by Foreign Institutional Investors (FIIs) in government securities and other corporate bonds and loans by the financial institutions in the form of external commercial borrowings (ECBs) of businesses.

All the non-banks and the rest of the world put together has provided roughly half of the credit of Rs. 300 lakh crores to governments, businesses and households in India.

Disruption Caused by Covid 19 Economic Lockdown

Covid-19 and economic lockdown has upended the finances of all three groups of borrowers, most stridently the businesses and government. Likewise, it has thrown in tailspin the lenders, most notably the banks and non-banks.

Borrowing requirements of the governments seem to have gone up sharply thanks to hit on tax receipts and new expenditure requirements to fund survival, revival and stimulus packages.

Non-performing loans of banks, especially from businesses, are going to see a large spike thanks to destruction of value-added and severe impact on financial viability of numerous businesses.

Financial institutions, like NBFCs, seem to be in the midst of big turbulence on account of their funding sources drying up.

Liquidity for the governments, banks, non-banks and borrowers has become a matter of survival.

Issues with Respect to Credit to Governments

The governments borrow about 7-8% of GDP every year, including off-budget. For 2020-21, their normal estimated combined deficit/borrowings are about Rs. 15 lakh crores.

Economic disruption caused by Covid-19 and the most stringent economic lockdown is likely to lead to additional borrowing requirements of about Rs. 10 lakh crores for the Centre and Rs. 5 lakh crores for state governments.

This is another Rs. 15 lakh crores doubling the fiscal deficit and borrowings.

The central government has not so far accepted formally any requirement for additional borrowing. The government has, in fact, raised lesser than normal long-term market borrowings (10 year or more) in April, but has increased borrowings in the sub five-year buckets.

The government has also availed of much larger ways and means advances. RBI’s ways and means advance to the central government was Rs. 1.11 lakh crore on 10^th April, 2020. Last year on 12^th April 2019, it was zero. RBI has again raised the ways and means advance limit of central government to Rs. 2 lakh crores.

The central government is the best credit and the way the central government chooses to finance it has enormous implications for the financial system and availability of credit to businesses and households.

This raises several issues:

Can the central government meet its additional borrowings requirement by increased ways and means advances?

Is it advisable to keep the lid on additional borrowing requirement and maintain the façade of normalcy by keeping the six-monthly borrowing calendar unchanged? 

Will the market be able to finance normal and additional borrowing requirement of the central government in the usual manner? Or, it will be necessary to monetise the additional deficit?

How much will the state governments be allowed to borrow more and how would states raise their additional borrowing requirements?

Issues Connected with Credit to Businesses

Approximately 15% of the current stock of credit to businesses or about Rs. 15 lakh crores were locked up in non-performing businesses even before Covid-19 crisis struck.

Covid-19 is dealing a deadly blow to several businesses- transport, travel, entertainment, sports etc. A significantly sharp spurt in non-performing loans of credit providers- banks and non-banks alike- looks imminent. While it would require a borrower by borrower assessment, it would not be surprising if the non-performing business loans double to about Rs. 30 lakh crores.

Economic lockdown is going to make several performing ‘non-essential’ businesses suffer losses. These would surely lose a lot of their working capital. Many businesses will require additional working capital.

Several businesses would need to make additional investments to make their businesses Covid-19 risk free. Some businesses would make additional investments to capture new or enhanced opportunities.

There might also be additional borrowing requirement of, let us assume, about Rs. 10 lakh crores, over and above normal annual requirement, to revive the businesses, make investments to restructure businesses to manage covid-19 risk and to maintain higher working capital.

How is our financial system- the regulator, banks and non-banks- going to recognise, resolve and fund new non-performing loans?

Is our financial system in a position to meet the normal and additional credit requirement of businesses this year?

Issues in Credit to Households

More than half of the outstanding household credit is for financing housing. Almost entire household credit is a performing asset. There are very small delinquencies. There is also the comfort of collateral. Loans to builders and real estate companies, which are under pressure, are business loans.

There might be somewhat increased demand for vehicle loans. Housing loans demand is unlikely to change materially. There might be some slowdown in credit demand for other consumer durable assets. Some providers of housing credit might actually be in strong need of liquidity.

Does household credit segment need any policy intervention? Is moratorium on servicing of housing loans necessary? Is there a need to further encourage securitisation of housing loans?

The Bankers’ Dilemma

Provision of credit is the raison d’etre of the banking system.

The Banks primarily source their funds from the savers but also create credit.

The Banks, especially public sector banks (PSBs), have become quite risk averse in the face of mounting non-performing loans and frauds. The banks and other lenders are going to face another wave of non-performing loans.

On the contrary, the lenders will get much larger demands than usual from businesses, more from the ones with weaker credits.

The banks and the non-bank lenders have turned to the RBI for helping manage the mounting non-performing loans, raising additional resources and to deal with this grossly unusual situation.

The RBI has allowed the banks to grant moratorium for three months on servicing of loans. RBI has also opened up facility for banks to acquire lending resources for periods as long as three years at very low rates (Targeted Long-Term Repo or TLTRO facility). RBI has reduced reverse repo rate (where the banks park their excess cash) to as low as 3.75% to ‘force’ banks to lend and not park. RBI has reduced Cash Reserve Ratio (CRR) by 1%. It has taken quite a few other decisions announced in two packages by the Governor.

Is this package of measures going to make Indian banks, especially PSBs, lend to businesses? Will banks buck up and meet new credit demand or will they will find ways to duck it?

Does granting moratorium to credit servicing, not recognising the imploding asset quality and suspending bankruptcy law amount only to pushing the can down the road?

Is the policy of ‘forcing’ the banks to lend by bringing down the reverse repo rate working?

Is it time for RBI to also assume some credit risk and provide credit to businesses?

Problems of Non-Banks

Non-banks- NBFCs and HFCs- are major source of credit to some kind of businesses and households. They source funds from banks and other non-bank players in the system. Moratorium policies are affecting NBFCs differently than the banks. Their own credit may also get down-graded making the financing institutions to turn away from them.

What is the shape of things to come for Non-Banks? Are these, especially the smaller NBFCs, facing existential crisis?

Considering that banks reach to households and small businesses is costlier, does it make sense for banks to become wholesalers and non-banks their retailers?

Are FII Lenders Fair Weather Friends

FIIs have been selling Indian debt. In March, they sold over 35000 crores of Indian debt. The spread and swap premiums on ECBs are likely to go up. India has encouraged FIIs buying Indian debt- both government and corporate- in rupees. This practice has been further encouraged by recent decision to create special securities in which there would be no limits on FIIs holding debt. This has been done to make Indian debt part of the global debt indices.

Is the policy of foreigners investing in Indian debt in rupee serving our interests?

Are FIIs fair weather friends, more particularly in the context of debt, and should we restrict this route?

I explore these questions and issues in second and third parts of this series of blogs.  

SUMMARY

Combined outstanding borrowings or credit of the governments, businesses and households in India is of the order of Rs. 300 lakh crores or $4 trillion @ Rs. 75 to a dollar.

The central government and the state governments together owes about Rs. 140 lakh crores. Outstanding credit of businesses of all types is about Rs. 100 lakh crores. Estimated stock of credit held by the households is about Rs. 50 lakh crores.

In India, credit for wealth investment- speculative real estate, equity investment, bonds investment etc. is of relatively minor order. Likewise, Indian financial system has also not provided any credit to the rest of the world being a capital deficit country.

India’s GDP is about Rs. 200 lakh crores. The outstanding credit stock of Rs. 300 lakh crores amount to 150% of GDP.

The banks are the biggest providers of credit. Outstanding bank credit to the final users- businesses, governments and households- is about Rs. 130 lakh crores. Including credit funded indirectly, through non-banks, banks outstanding credit is close to Rs. 140 lakh crores.

Besides being a regulator, RBI also create and provide credit. RBI is banker to the government and is bankers’ bank as well. Presently RBI lends only to the government. Outstanding credit of RBI is about Rs. 10 lakh crores.

Inclusive of RBI’s credit, the banking systems’ credit to ultimate borrowers- the governments, businesses and households- amounts to Rs. 150 lakh crore or about half of the total credit of Rs. 300 lakh crores.

All the non-banks, retirement and insurance savings institutions and the rest of the world put together has provided roughly half of the credit of Rs. 300 lakh crores to governments, businesses and households in India.

Covid-19 and economic lockdown has upended the finances of all three groups of borrowers, most stridently the businesses and governments. Likewise, it has thrown the lenders in tailspin, most notably the banks and non-banks.

The government would be needing additional credit to meet the fiscal hole caused by covid-19 and economic lockdown. The existing stock of credit to businesses is likely to face severe downgrade ballooning the non-performing loans of banks and non-banks.

The central government has so far not expressed its intent to increase its borrowing despite strident call of survival, revival and stimulus packages or how it proposes to fund it.

RBI has opted for postponing the inevitable by granting moratorium and tweaking the recognition norms. RBI has also tried to provide cheaper and longer credit to banks to persuade them to lend. Banks have so far not taken the bait and deposited more than double the cash provided with RBI in reverse repo deposits.

There are several issues connected with financing of enlarging government deficits, falling credit-worthiness of businesses, increasing demand to fund relatively poor credit and the like.

I explore issues connected with the banking system and the rest of financing system in next blogs in this series.

SUBHASH CHANDRA GARG

NEW DELHI 22/04/2020